This working paper is forthcoming in the Journal of Macroeconomics, so the definitive version is not yet available.

While the paper is clearly an important contribution, and is a useful study worth reading, it is not by any means an attempt to gauge the success of a modern Keynesian system of macroeconomic management, full employment, and effective financial sector regulation. This is a paper judging the success of the Federal Reserve in the full period of its existence. The earlier part of that period (1913–1934) was much more like the 19th century in terms of fiscal policy and financial regulation, than the post-1945 period.

I also have a number of problems with the work of Selgin, Lastrapes and White (henceforth Selgin et al.), as follows:

(1) Merely focussing on a central bank seems a limited test of the superiority of modern macroeconomic interventions and Keynesian management of an economy. Moreover, just focusing on the US also ignores evidence from other nations. One conclusion of this paper – that the Fed existed during the worst deflationary output collapse in American history (Selgin et al. 2010: 9) – is no surprise. The Great Depression was the result of severe government failures to provide macroeconomic stability, principally fiscal and GNP stabilisation, and measures to stop banking sector collapse.

(2) Selgin et al. (2010: 10) state:

“According to Romer’s … pre-1929 GNP series, which relies on statistical estimates of the relationship between total and commodity output movements (instead of Kuznets’ naïve one-to-one assumption), the cyclical volatility of output prior to the Fed’s establishment was actually lower than it has been throughout the full (1915–2009) Fed era (Table 2, row 2 and Figure 5, second panel). More surprisingly, pre-Fed (1869–1914) volatility (as measured by the standard deviations of output from its H-P trend) was also lower than post-World War II volatility, though the difference is slight. (Selgin et al. 2010: 10)

Yet it appears to me that comparing the full 1915–2009 period with 1869–1914 is misleading. Why? Because it conflates three periods of distinct government macroeconomic policy from 1915 to 2009:

(1) the pre-1934 period in which modern Keynesian fiscal policy did not exist. This period was essentially like policy in the late 19th century.

(2) the 1946–1970s period of Keynesian economics.

(3) The post 1979–2009 neoliberal macroeconomic period, with its obsession with inflation targeting, and abandonment of full employment Keynesian fiscal policy (from about 1989 in the US).

Period (1) saw the Great Depression, so it is obvious this distorts the data when it is lumped in with periods (2) and (3). A proper gauge of the superiority of period (2) requires looking at the data between about 1947–1973.

Furthermore, although the “… pre-Fed (1869–1914) volatility (as measured by the standard deviations of output from its H-P trend) was also lower than post-World War II volatility” according to Romer’s data, even Selgin et al. admit that the difference is slight. And even that comparison is distorted by the 1979–2009 neoliberal period.

Moreover, as is well known, the whole subject of accurate estimates of pre-1914 US GNP is plagued with problems, as even Selgin et al. (2010: 10) admit:

“Romer’s revisions have themselves been challenged by others, however, including Zarnowitz (1992, pp. 77-79) and Balke and Gordon (1989). The last-named authors used direct measures of construction, transportation, and communication sector output during the pre-Fed era, along with improved consumer price estimates, to construct their own historic GNP series. According to this series, the standard deviation of real GNP from its H-P trend for 1869 to 1914 is 4.27%, which differs little from the standard–series value of 5.10%. Balke and Gordon’s findings thus appear to vindicate the traditional (pre-Romer) view … .” (Selgin et al. 2010: 11).

Balke and Gordon (1989) do not support Romer’s findings, and provide support for the view that pre-1914 output volatility was worse than the post-1945 period.

“Fiscal stabilizers, whether automatic or deliberately aimed at combating downturns, are also likely to have contributed to reduced output volatility since the Fed’s establishment, when state and federal government expenditures combined constituted but a fifth as large a share of GDP as they did just before the recent burst of stimulus spending (Figure 8). Thus DeLong and Summers (1986) claim that the decline in U.S. output volatility between World War II and the early 1980s was due not to improved monetary policy but to the stabilizing influence of progressive taxation and countercyclical entitlements. Subsequent research … documents a pronounced (though not necessarily linear) relationship between government size and the volatility of real output. According to Mohanty and Zampoli, a 10% increase in the government’s share of GDP was associated with a 21% overall decline in cyclical output volatility for 20 OECD countries during 1970–1984. (Selgin et al. 2010: 14–15).

(4) Selgin et al. (2010: 23) find that “no genuine post-1913 reduction in banking panics, or in total bank suspensions, took place until after the national bank holiday of March 1933.” They further find that it was the Reconstruction Finance Corporation (RFC) and Federal Deposit Insurance Corporation (FDIC) that were the primary policy measures contributing to banking stability. That doesn’t surprise me.

(5) Selgin et al. (2010: 25) declare that the US banking panics of the 19th century were caused by “misguided regulations, including those responsible for the highly fragmented structure of the U.S. banking industry, played in making the U.S. system uniquely vulnerable to panics.” This might be true to some extent. Only the most irrational person would contend that regulation can never do harm. Regulation might be poorly designed and have bad effects. But good regulation is quite different.

Selgin et al. (2010: 25) further cite the work of Bordo (1986), who found that the UK, Sweden, Germany, France, and Canada were largely free from the type of banking panics that the US suffered in this period (1870–1933).

“… Canada’s experience is especially revealing. Unlike the U.S., which had almost 2000 (mainly unit) banks in 1870, and almost 25,000 banks on the eve of the Great Depression, Canada never had more than several dozen banks, almost all with extensive branch networks. Between 1830 and 1914 (when Canada’s entry into WWI led to a run on gold anticipating suspension of the gold standard), Canada experienced few bank failures and no bank runs. It also had no bank failures at all during the Great Depression, and for that reason experienced a much less severe contraction of money and credit than the U.S. did. Although the latter outcome may have depended on government forbearance and implicit guarantees which, according to Kryznowski and Roberts (1993), made it possible for many Canadian banks to stay open despite being technically insolvent for at least part of the Great Depression period, the fact remains that Canada was able to avoid banking panics without resort to either a central bank or explicit insurance. (Selgin et al. 2010: 25).

Yet the citation of Kryznowski and Roberts (1993) requires that it was government intervention and implicit guarantees that provided banking stability for Canada during the Great Depression. Moreover, while the modern Canadian central bank – the Bank of Canada – did not exist until 1935, the Bank of Montreal appears to have functioned as a de facto central bank for Canada from the 1860s until 1935. This doesn’t support Selgin et al.’s case.

Bordo (1986) finds that the UK, Sweden, Germany, France, and Canada had a degree of banking stability from 1870 to 1933 that the US lacked. Yet all those nations had official central banks or de facto central banks in this period. What conclusion does that suggest? I submit to you it is not the conclusion of Selgin et al.

I would also like to point out that Selgin et al.’s graph (figure 9: “US bank failures as percentage of all banks, 1896 to 1955”) shows that modern financial sector regulation from 1934 appears to have minimised bank failures to zero or at least to an insignificant level compared to the pre-1934 system.

Hayek’s original view of fractional reserve banking can be found in Hayek’s essay Monetary Theory and the Trade Cycle (1929; English trans. 1933 by N. Kaldor and H.M. Croome; see Hayek 2008: 1–130):

“It follows particularly from the point of view of the monetary theory of the trade cycle that it is by no means justifiable to expect the total disappearance of cyclical fluctuations to accompany a stable price level—a belief Professor Lowe seems to regard as the necessary consequence of the monetary theory of the trade cycle. Professor Röpke is undoubtedly right when he emphasizes the fact that ‘even if a stable price level could be successfully imposed on the capitalist economy the causes making for cyclical fluctuations would not be removed.’ But to realize this, as the preceding argument shows, is by no means ‘equivalent to a rejection of a 100 percent monetary Trade Cycle theory.’ On the contrary, on this view, we must regard Professor Röpke’s theory, which coincides in the more important points with our own, as itself constituting such a 100 percent monetary trade cycle theory.

Once this is realized, we can also see how nonsensical it is to formulate the question of the causation of cyclical fluctuations in terms of “guilt,” and to single out, e.g., the banks as those ‘guilty’ of causing fluctuations in economic development. Nobody has ever asked them to pursue a policy other than that which, as we have seen, gives rise to cyclical fluctuations; and it is not within their power to do away with such fluctuations, seeing that the latter originate not from their policy but from the very nature of the modern organization of credit. So long as we make use of bank credit as a means of furthering economic development we shall have to put up with the resulting trade cycles. They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them. And even if it is a mistake—as the recurrence of crises would demonstrate—to suppose that we can, in this way, overcome all obstacles standing in the way of progress, it is at least conceivable that the non-economic factors of progress, such as technical and commercial knowledge, are thereby benefited in a way we should be reluctant to forgo.” (Hayek 2008: 101–102).

Two points emerge, as follows:

(1) This passage appears to have been written before the first edition of Prices and Production (1931; 2nd edn. 1935), and is quite compatible with Hayek’s view of business cycles in those works. Fractional reserve banking is not fraudulent, nor are fiduciary media. Fractional reserve banking is a product of free market exchange. Thus, even if we were to accept the Austrian business cycle theory, cycles would be an endogenous outcome of market processes where voluntary fractional reserve banking exists.

Robert Skidelsky has a relevant insight into the reception of Hayek’s Austrian trade cycle theory in the 1930s:

“Hayek, like Keynes, hoped to prevent a slump from developing by preventing the credit cycle from starting. But his method was very different. It was to forbid the banks to create credit, something which could be best achieved by adherence to a full gold standard. He was quite pessimistic, though, about this being practical politics, so his conclusion, like Keynes’s, was that a credit-money capitalist system is violently unstable – only with this difference, that nothing could be done about it. One can understand why Hayek’s doctrines attracted a certain kind of socialist: they seemed to reach Marx’s conclusions by a different route. Because of the Austrian school’s close attention to the institutional and political setting of a credit-money economy, Hayek’s picture of the capitalist system in action was altogether more sombre than that of conventional Anglo-Saxon economics, with its story of easy adjustments to ‘shocks.’” (Skidelsky 1992: 457).

The Austrian trade cycle theory requires that real world capitalism has been severely flawed for over two centuries, and serious entertainment of the theory also leads to the conclusion that the history of modern capitalism has been nothing but an endless series of unsustainable cycles.

(2) But even this passage shows Hayek’s flawed thinking: capitalist economies have many periods where resources are idle and international trade allows the importing of scarce resources. Under such circumstances, fractional reserve banking is a highly efficient way of inducing investment by creating credit. Furthermore, the unique Wicksellian natural rate of interest – which underlies Hayek’s theory – is a non-existent,non-operational concept outside of equilibrium. Nor is the time preference theory of interest used by Austrians in their expositions of the Austrian business cycle theory sound.

Hayek’s assumption that fractional reserve banking results in extortion of real resources from savers is not true when the economy has significant idle resources and unused capacity. And even when relative scarcity for some commodities exists, economies can obtain goods by international trade.

Tuesday, February 28, 2012

I post below an interview with Wynne Godley (2 September 1926–13 May 2010), which was conducted on 16th September, 2008. Godley made contributions to Post Keynesian economics and some of his work has been influential for MMT.

First, I intend to examine this assertion in light of the real GNP estimates of (1) Balke and Gordon and (2) Romer.

Secondly, I will examine the real GNP growth rates for the 1873–1896 period, in which there was almost continuous deflation in the US and in many other Western nations (on this period of deflation, see Saul 1985; Capie and Wood 1997: 287–288).

Thirdly, I will look at the unemployment estimates of Vernon (1994) for this period.

It is not possible to declare that either 1879–1894 or 1873–1896 was “the most productive” in American history.

I. Real US GNP, 1879–1894
The GNP estimates of Balke and Gordon (1989: 84) are as follows (I have added the annual growth rates by my own calculation):

We thus have an average growth rate of 3.67%. The average real US GNP growth rate from 1947–1973, during the classic era of Keynesianism, was 3.86%, higher than 1879–1894, so it is not possible to declare 1879–1894 “the most productive in period in American history,” on the basis on real output growth estimates of Balke and Gordon.

The figures for GNP in Romer are here (I have added the annual growth rates by my own calculation):

So matters aren’t any better by looking at Romer’s estimates. In fact, they are worse: the average real GNP growth rate from 1879–1894 was 3.36%, lower than the average calculated from Balke and Gordon’s figures.

Now let’s look at the entire 1873–1896 period.

II. Real US GNP, 1873–1896
The estimates of Balke and Gordon (1989: 84) for 1873–1896:

Most interesting is that average rates fell in the 1881–1890 period (to 2.96%), and then again (to 2.40%) in 1891–1896 in the last years of the deflation.

Why did growth fall? Did it have anything to do with shocked business expectations and business pessimism in this period, which negatively affected the level of investment? If one bothers to look at contemporary accounts in the business press in both Europe and America in this era, one finds numerous complaints of reduced profits and pessimism. Unless you think shocked business expectations do not affect the level of investment, then there is a clear case that investment levels fell below what they could have been, perhaps in a number of nations.

Let us move on to the figures for GNP in Romer, which are below (I have added the annual growth rates by my own calculation):

Romer’s figures show an average of 3.87%. This was only very slightly higher than the average real US GNP growth rate from 1947–1973 (3.86%). Even if we take the most favourable GNP estimates of Romer, the average is only higher than the average for 1947–1973 by a tiny margin. In fact, it is not even significant.

Finally, here are some decadal rates from Romer’s data and the averages for the 1873–1880 and 1891–1896 periods:

While 1873–1880 did have an unusually high average growth rate (5.76%), the rate slumped in the 1881–1890 period to just 2.72%, the core period of the deflation from 1873–1896. The latter fall in growth rates in the 1880s is confirmed in Balke and Gordon’s estimates. By Romer’s estimates, the 1891–1896 period average rose to 3.28%.

III. Unemployment, 1873–1896
There are a number of estimates of US unemployment in the late 19th century. One of the widely-cited estimates is that of J. R. Vernon (1994), although other estimates are considerably worse than those of Vernon, especially in the 1890s, such as the work of Lebergott or Romer (1986). Vernon’s (1994) estimates are as follows:

I have highlighted in yellow those years where unemployment was over 5% and the years where unemployment showed a tendency to rise when it was above 5%.

According to the figures of Balke and Gordon (1989: 84), the US had negative GNP growth in 1874, 1888, 1893–1894, and 1896. There is a correlation between these recessions and rising unemployment in Vernon’s estimates.

But more puzzling is the marked rise in unemployment in the 1875–1878 period. According to the GNP estimates of Balke and Gordon, the US had positive GNP growth rates from 1875–1878, yet unemployment rose in this period. Earlier estimates of GNP showed that the US economy experienced a recession in these years, with the NBER data showing the longest recession in US history from October 1873 to March 1879 (a 65 month recession). At the very least, there appears to have been contraction in certain important sectors. This confirms that something was wrong with the US economy even in the 1870s, and that revised annual GNP estimates do not necessarily give us an accurate picture of the health of the economy on their own.

On the metric of unemployment, the 1873–1896 period saw high unemployment from 1875–1878 and from 1893–1896. While unemployment was relatively low in the 1880s, that period did not have particularly high growth rates.

Moreover, as I have mentioned above, other estimates put unemployment at higher levels for the 1890s. We can review the unemployment estimates in Romer (1986: 31) for the 1890 to 1896 period below:

By these figures, the 1873–1896 period of deflation ended with double digit unemployment.

IV. Conclusion
Nearly all of the average real GNP estimates for either 1879–1894 or 1873–1896 show inferior growth to the 1947–1973 period. Only the GNP estimates of Romer for 1873–1896 show a slightly higher average, but it is only by a tiny margin, which cannot be regarded as significant.

By the criterion of unemployment, the 1873–1896 period saw high unemployment from 1875–1878 and from 1893–1896.

Saturday, February 25, 2012

I am currently re-reading some biographies of John Maynard Keynes (5 June 1883–21 April 1946): namely, D. E. Moggridge’s Maynard Keynes: An Economist’s Biography (London, 1992), and Robert Skidelsky’s John Maynard Keynes: Hopes Betrayed 1883–1920 (vol. 1; London, 1983). Both are the best biographies of Keynes available, and Skidelsky’s is the most detailed (it runs to 3 volumes).

I have written up some biographical details of interest below:

(1) The Keynes family might have been descended from a Norman called William de Cahaignes (c. 1035–?) who came to England with William the Conqueror in 1066. The Norman surname Cahaignes was derived either from the Late Latin casnus (“oak”) or from Latin catanus (“juniper bush”; Skidelsky 1983: 2). The young Keynes, while in his last years at Eton, did genealogical research on his family, and traced his dynastic origins to this Norman baron. According to Skidelsky (1983: 2), Keynes even constructed a family tree back to William de Cahaignes, but whether this was really true or merely wishful thinking is not clear (Skidelsky [1992: 3] refers to problems linking the 17th century Keyneses with the 18th century ones, like Richard Keynes [who died in 1720] from whom Maynard Keynes really was descended*).

(2) Keynes’s immediate ancestors came from Wiltshire: Keynes’s paternal grandfather was John Keynes (1805–1878) of Salisbury, a businessman who made his money in flower nurseries, and then banking and other business (Skidelsky 1983: 5). John Keynes’s second marriage was to Anna Maynard Neville, who was from an Essex farming family (Skidelsky 1983: 5). Their son was Keynes’s father, John Neville Keynes (31 August 1852–15 November 1949).

(3) Keynes’s mother was Florence Ada Brown (1861–1958). John Neville Keynes and Florence had three children:

John Neville Keynes died at the age of 97, and actually outlived John Maynard Keynes. For a useful family tree, see here (at the end of the article). Amongst Keynes’s indirect descendants is the actor Skandar Keynes.

(4) John Neville Keynes was a conventional Liberal in politics. First, he was a supporter of the Liberal politician William Ewart Gladstone, but later opposed Gladstone’s first Home Rule Bill for Ireland (1886). Neville Keynes had become a Liberal Unionist by the 1890s (Skidelsky 1983: 56–57).

(5) John Maynard Keynes was born on 5 June 1883 at 6 Harvey Road in Cambridge, the family home. At the time, the British Empire was a superpower, and the Prime Minister in the year of Keynes’s birth was William Ewart Gladstone (in his second premiership from 1880–1885). It was the year after the British occupation of Egypt (1882), and the year before the 1884 Reform Act, which gave around six million the vote in British parliamentary elections.

(6) Keynes was known as Maynard Keynes or Keynes; his father used the name “Maynard,” and only his mother preferred the name John (the name of Keynes’s father), which she used in her correspondence until about 1901 (Moggridge 1992: 22; Skidelsky 1983: 1, n.).

(7) The young John Maynard Keynes lived at 6 Harvey Road in Cambridge. His father John Neville Keynes was an administrator at Cambridge University and held a lectureship in Moral Science from 1883 to 1911. In those days, economics was held to be a branch of the Moral Sciences, a term coined by John Stuart Mill in 1843, and used to describe history, law, economics (better known as Political Economy in the 19th century), psychology, anthropology and ethics. Economics was taught as part of the Moral Sciences Tripos at Cambridge, and it was not until 1903 under the initiative of Alfred Marshall that an independent Economics and Political Tripos (that is to say, a Bachelor’s Degree with honours) was established at Cambridge (Skidelsky 1983: 45).

(8) Keynes began playing golf with his father John Neville Keynes in the 1890s, but Maynard Keynes was terrible at golf, and C. R. Fay held Keynes to be amongst the “world’s worst players” (Moggridge 1992: 21).

(9) From the time when he was 6 years old, Maynard was convinced he was “remarkably ugly,” a felling which continued into adulthood (Skidelsky 1983: 45, 86). Skidelsky (1983: 45) speculates on the psychological implications of this: perhaps it caused him to be a rather more intellectual, “cerebral” child, and may have contributed to his periods of depression.

(10) Keynes had two German governesses in the 1890s, who, according to Skidelsky (1983: 55), gave him a “good grounding in German,” and might explain Keynes’s pro-German feelings later in life.

(11) the young Keynes excelled at mathematics (Moggridge 1992: 27), and this was the key to his success in the Eton College Scholarship Examinations he underwent in July 1897 (Moggridge 1992: 28). Keynes began his education at Eton in September 1897 (Skidelsky 1983: 74) when he was 14, as one of Eton’s “Collegers” (or King’s Scholars), as opposed to the “Oppidans,” fee-paying students, usually from wealthier or upper-class backgrounds. In July 1901, Keynes won the “Tomline,” an Eton mathematical prize, and in January 1901 was elected to the Eton “College Pop,” a debating society.

(12) Maynard thought of himself as firmly middle class, and some early opinions persisted later in life: aristocrats he found ridiculous and the proletariat boorish (Skidelsky 1983: 84–85); he dismissed religion, even refuting arguments for the existence of god held by his friends (Skidelsky 1983: 86). In 1899 while at Eton, on the 80th birthday of Queen Victoria, Keynes wrote a student essay called “Victorian Achievements.” In it, he evinces a somewhat poor view of workers and labour rights:

“It is very well to encourage a labourer to think for himself … but when his little knowledge leads to strikes, it must be admitted that it is a dangerous thing.” (quoted in Skidelsky 1983: 88).

Of course, Keynes was only 16 when he wrote these words.

Keynes was anti-war before the Boer War (11 October 1899 until 31 May 1902), but once the conflict started supported Britain’s effort (Skidelsky 1983: 88). Nevertheless, his patriotism did not extend to joining the “Volunteers” at Eton, despite the social pressure to do so (Skidelsky 1983: 88; 90; Moggridge 1992: 42).

(13) Keynes’s curriculum at Eton consisted mainly of Classics (that is, ancient Greek and Latin and the literature of the ancient Greeks and Romans), mathematics, history and French.

(14) In July 1902, Keynes came first in the Higher Certificate Examination, and decided on attending King’s College, Cambridge, where he would study mathematics and Classics (Skidelsky 1983: 98–99; Moggridge 1992: 46).

Timeline of Keynes’s Early Life
– born on 5 June, 1883 at 6 Harvey Road in Cambridge;
– Keynes began study at Eton in September 1897;
– educated at Eton from 1897–1902;
– educated at King’s College, Cambridge from 1902–1905; Keynes received a first class B.A. in mathematics in May 1904. In June 1905, he underwent the Tripos examinations (the equivalent of obtaining an Honours degree), and was ranked in twelfth place.

NOTE
* The genealogical line mentioned by Skidelsky (1983: 3) is as follows:

Geoffrey Colin Harcourt (1931– ) is an Australian Post Keynesian, with an academic career at the University of Melbourne, University of Adelaide and King’s College, Cambridge. He is now a visiting professorial fellow at the Australian School of Business.

He talks here with Julian Lorkin about his career and contributions to Post Keynesianism.

Friday, February 24, 2012

There is a peculiar, ridiculous question parroted by internet Austrians I have noticed of late: “why is it alright to destroy savings via Keynesian policies?,” they cry. By this, they presumably mean that central bank creation of reserves and Keynesian stimulus produce price inflation.

But the question in fact reveals deep ignorance of the basic nature of capitalism.

The endogenous money system confers benefits: it meets demand for credit for trade, commerce and investment. A consequence of the process is that it often produces price inflation when booms occur (that is, strong expansions in the business cycle). Even in the 19th-century, gold-standard era, booms were basically inflationary (outside of the historically aberrant 1873–1896 period). For example, the US had price inflation under the gold standard in the following booms: 1811–1814, 1825, 1834–1837, 1844–1847, 1841, 1852–1855, 1857, 1859, 1880, and 1896–1914. In particular, there was a period of protracted price inflation in most Western nations from 1896–1914. And note that the United States had no central bank for most of this period.

Modern central bank endogenous monetary systems merely continue what was already a fundamental feature of earlier capitalism, but provide a degree of monetary stability that many previous FR systems lacked. The consequences of prohibiting FRB would be blatant violation of private free contract. The Austrian claims that FRB is fraudulent or immoral are simply nonsense.

The alternative system favoured by some Rothbardians – a system of perpetual deflation – would impose a “tax” on producers and businesses that take on debt to expand output and increase employment: the deflation tax would penalise productive businesses and individuals who must pay back their debts with money of higher purchasing power. The economy would also experience debt deflationary effects.

There would also be powerful disincentives to capital goods investment. By holding money idle, savers would have a guaranteed return. The relentless deflation would also, after some years (say, a 100 years or so) see an astonishingly unequal and high disparity of wealth, if the original society had significant wealth inequality.

As for properly-designed Keynesian stimulus policies, they too confer benefits that outweigh the costs of price inflation. First, price inflation is mostly a secondary effect of stimulus during deep depressions or severe recessions, when idle resources, unused capital goods and unemployment exist. The primary effects of stimulus in the latter circumstances are increases in output and employment. Secondly, the creation of greater employment and output drives real GNP to hit its potential. This makes the community richer than it would otherwise have been, if real GNP had fallen below its potential, and provides a greater level of income owing to higher levels of employment.

“There are two types of deflation that free bankers like to talk about: secular and monetary. The first they consider benign, and it results from output increasing at rates faster than the supply of money.”

Yet his statement that there is “no theoretical basis for [sc. a deflation tax on debtors], and ... no empirical basis for this” is an assertion without evidence.

Why wouldn’t secular and monetary deflation force debtors to pay back money in higher purchasing power terms, effectively making the burden of their debts higher? Catalán has not, in any way, demonstrated why this would not happen.

(2) Catalán states:

“none of the problems that LK describes came up [sc. in 1873–1896]. In fact, this period was amongst the most productive in the history of the United States (if not the most productive).”

I disagree:

(i) there was a great deal of business pessimism in this period, negatively affecting business expectations. If one bothers to look at contemporary accounts in the business press in both Europe and America, one finds numerous complaints of reduced profits and pessimism. Unless one thinks that shocked expectations do not affect the level of investment, then there is a clear case that investment levels fell below what they could have been.

(ii) there were clear debt deflationary effects in this period. Above all, farmers were pressing for relief from debt deflation. The burden of their debts rose. This was not simply caused by industrialization of agriculture, nor by the fall in the size of agricultural employment in the labour force.

(iii) in this period, the deflation from 1873–1896 caused a popular movement to demand a increased money stock by free silver, often backed by debtors.

(3) Catalán remarks:

“as I note in the review [of Higg’s work on 1873–1896], during this period, moneylenders actually allowed for a dynamic interest rate, which would let the rate on loans fall with prices.”

Yet there were clearly considerable numbers who did not. Otherwise there would not have been significant complains about the burden of debt. Unless you were to legislate to make bankers take account of deflation in contracts, there would not be an evasion of debt deflationary effects.

First, credit where credit is due: Horwitz is perfectly correct that Hoover was not a liquidationist. Hoover is unfairly caricatured as an advocate of the extreme liquidationist solution to the Great Depression, a solution which was actually recommended by Andrew Mellon (US Treasury Secretary from 1921–1931). In truth, Hoover rejected extreme liquidationism, and attempted to fight the onset of the Great Depression with a number of limited interventions, including increased government spending. On this, Krugman is wrong to suggest that Hoover was a true liquidationist or that he advocated “savage spending cuts.” Horwitz gets this right, but the rest of his post is poor history without proper context.

Let us review the points Horwitz makes:

(1) First, some background. In the US, the fiscal year before 1976 ran from July 1 to June 30 in the next year. So in the relevant years the actual fiscal years were as follows:

“The 1929 budget was $3.1 billion, and Hoover’s first budget in 1930 had $3.3 billion in spending, followed by $3.6 billion, $4.7 billion, and $4.6 billion over the following three years.”

Yet Horwitz leaves out the following crucial points:

(i) In fiscal year 1930 (July 1, 1929 – June 30, 1930), as the depression became a very serious contraction indeed, Herbert Hoover actually ran a federal budget surplus, not a deficit. The net effect of federal fiscal policy on its own was contractionary, not expanionary. Hoover’s first deficit was in fiscal year 1931, when the US economy had already begun contracting severely.

(ii) The Federal Reserve raised the discount rate in 1931.

(iii) Hoover also cut spending in fiscal year 1933, and the net effect of federal fiscal policy in fiscal 1933 was contractionary against 1932. This was made worse by the Revenue Act of 1932 (June 6) which increased taxes across the board and applied to fiscal year 1932 and subsequent years (a measure which, curiously, Horwitz later mentions, but fails to understand properly). These were highly contractionary measures, and these two policies are the very antithesis of Keynesianism!

(iv) This leaves us with fiscal years 1931 and 1932. In both years it has long been known that federal fiscal policy was mildly expanionary, but not large relative to the GNP collapse. In 1931, for example, fiscal expansion included the Veterans’ Bonus Bill, but this was passed over Hoover’s objections. Hoover does not look like a big spending Keynesian on this score.

Now the budget may have expanded demand by 2% of GNP in 1931 more than the 1929 budget, but this was not large relative to the collapse of GNP, which is the key (Temin 1989: 27–28). In 1931, GNP collapsed by 16.11% relative to its level in 1930, from $91.2 billion to $76.5 billion. That is to say, in 1931, US GDP collapsed by $14.7 billion dollars, in a debt deflationary spiral with bank failures and a collapse in consumption, employment and investment. If we assume a multiplier of 4 (which is very high), then Hoover’s federal spending increase of $257 million dollars in fiscal year 1931 might have generated at most $1.028 billion of GDP in fiscal year 1931 (the effect of state and local fiscal policy reduced this, however). But GDP fell by $14.7 billion dollars, and it is the height of idiocy to seriously argue that Hoover’s increase in spending in fiscal year 1931 could have prevented the depression, to offset such a catastrophic fall in GDP. It could never have done any such thing.

Much the same applies to fiscal year 1932. In 1932, US GDP collapsed by $17.8 billion dollars. If we assume a multiplier of 4 again, in theory Hoover’s federal spending increase of $1.082 billion dollars might have generated $4.32 billion of GDP in fiscal year 1932 (in practice, state and local austerity, however, counteracted the effect of federal fiscal policy). But that was not even remotely enough to stop a collapse in GDP of $17.8 billion dollars.

(2) Horwitz continues:

“In nominal terms, [sc. Hoover] … increased spending 48 percent over the last budget of the previous administration. However, this period was one of significant deflation, so if we adjust for the approximately 10 percent per year fall in prices over that period, the real size of government spending in 1933 was almost double that of 1929.”

There is a crucial point Horwitz leaves out: in 1929, total federal spending was only about 2.5% of GNP (Stein 1966: 189–223). Government spending as a percentage of GNP rose in 1929–1933 mostly because GNP collapsed, not because Hoover radically increased government spending. Look at the actual annual increases in federal spending here:

Total spending was cut in 1933. If we look at the federal spending increases in the 1920s, 6–7% increases in fiscal 1930 and 1931 were not really much larger than the annual increases that had happened in the 1920s. There was nothing spectacular about Hoover’s spending increases in fiscal 1930 and 1931. In fiscal 1930, Hoover actually ran a budget surplus and drained money and contracted demand in America’s economy.

The only year that does stand out is fiscal 1932, where there was a 30.25% rise over fiscal 1931. But even here we are talking about an increase of only $1.08 billion in a year when GNP fell by $17.8 billion dollars. Hoover’s increase in fiscal 1932 was feeble and ridiculously small compared to the scale of the GNP decline.

(3) Horwitz:

“The budget deficits of 1931 and 1932 represented 52.5 percent and 43.3 percent of total federal expenditures. No year between 1933 and 1941 under Roosevelt had a deficit that large.”

I am not sure how the first figure was calculated. In fiscal 1931 the federal budget was $3.577 billion and the deficit was $0.5 billion. I calculate that the deficit was merely 13.97% of total federal expenditures in fiscal 1931. In fiscal 1932, the deficit was 57.9% of total federal expenditures. But this figure is grossly misleading without further context. The deficit was not large relative to the size of the GNP collapse.

(4) Horwitz lists a number of interventions Hoover introduced in 1931, such as the Reconstruction Finance Corporation, Home Loan Bank, Hoover’s executive order on immigration, enforcement of anti­trust laws, and so on. A number of them have nothing to do with Keynesian fiscal stimulus, and even those that do (e.g., Public Works Administration, direct loans to state governments) were done on a scale far too small to stop the Great Depression.

(5) Horwitz:

“On top of those spending proposals, … Hoover proposed, and Congress approved, the largest peacetime tax increase in American history. The Revenue Act of 1932 increased personal income taxes dramatically, but also brought back a variety of ex­cise taxes that had been used during World War I. The higher income taxes involved an increase of the standard rate from a range of 1.5–5 percent to the 4–8 percent range. On top of that increase, the act placed a large surtax on higher-income earners, leading to a total tax rate of anywhere from 25 to 63 percent. The act also raised the corporate income tax along with several taxes on other forms of income and wealth.”

It is most extraordinary that this is presented as if it is evidence that Hoover was a Keynesian. Raising taxes like this in a depression is contractionary fiscal policy. If anything, a true Keynesian would have passed large tax cuts in 1932, not raised taxes. Hoover on this policy action was no Keynesian.

(6) Finally, Horwitz notes that some of the measures of the New Deal were already introduced by Hoover. Yet a number of the elements of the New Deal had nothing to do with Keynesian economics, and indeed Keynes himself denounced the National Industrial Recovery Act (NIRA). The New Deal was created by a hodgepodge of conflicting groups of ideologues and its programs were not all constructive from the modern Keynesian perspective at all.

(7) Finally, it is fascinating that Austrians like Horwitz never seem to look outside the United States at depression history. Those nations that recovered from the Great Depression or its aftermath rapidly and successfully – New Zealand, Japan and Germany – used large-scale fiscal stimulus:

Saturday, February 18, 2012

Anthropologists have long been aware of a special type of money in tribal societies and cultures with minimal markets, which can be called “non-commercial money,” “ceremonial money,” “‘primitive’ money,” “social currency,” “social money,” or “special-purpose money” (Graeber 2011: 130; Dalton 1965). The objects which function as “non-commercial money” are often high prestige goods or “treasures”: objects that were treated in tribal societies rather like “crown jewels or sports trophies in Western societies” (Dalton 1965: 59).

Often this type of money is non-commercial in the sense that it is not used for everyday purchases of goods and services, or only rarely for such ordinary goods. It is thus non-commercial in that it is not a universal medium of exchange. The purpose of such non-commercial money is social. It is used for the following:

(1) the creation of new social ties, such as marriage through bridewealth, or membership of societies;

(2) to prevent blood feuds or breaches in social relations, such wergeld, bloodwealth, or mortuary payments, and

Such non-commercial money might or might not have a peripheral role in market exchanges of everyday goods, but the primary purpose nevertheless appears to be social. It is even quite likely that (1) in our Stone Age past this type of “social currency” was the earliest thing recognisable as what we would call money, (2) that its non commercial function was for a long time far more important than the later “commercial” function, and (3) that non-commercial money long precedes commercial money (Einzig 1948: 983–984).

In 1949, A. H. Quiggin made important points about “non-commercial money”:

“The evidence suggests that barter in its usual sense of exchange of commodities was not the main factor in the evolution of money. The objects commonly exchanged in barter do not develop naturally into money and the more important objects used as money seldom appear in ordinary everyday barter. Moreover, the inconveniences of barter do not disturb simple societies. The variety of material and the complexities of uncivilized attitudes towards money preclude generalizations, but the evidence appears to support the following line of argument.
In the beginning Man lived in self-supporting and self-contained groups. Except in an area where provisions are unlimited, a society depending on hunting and food-gathering for its subsistence is necessarily unsociable and ‘has no truck’ with its neighbours. Early exchanges were in the way of present-giving, and were expressions of friendship with no ulterior economic purpose, although the latter – an expectation of an adequate or even improved return – cannot be excluded from human dealings. Present-giving or gift-exchange, seen in simple forms in the Andamans, Torres Straits or New Zealand, may develop into elaborate ceremonial as in Fiji or the North-West of America, but remain distinct from trading with money.
Barter develops between areas of contrasted produce, such as coastal and inland, forested and open country. We see the barter of fish or shells for vegetables, game for bananas, &c., in Melanesia or the Congo, and the establishment of regular markets. Trading voyages such as those of Torres Straits and New Guinea take us a stage further by the introduction of conventional presents. But so far there is no need for any medium of exchange such as is commonly described as money.
This is the state of affairs over about half the world at the present day. Barter suffices for most of the natives of Australia, New Zealand and the islands of the Pacific, and for the less-advanced peoples of Africa, Asia and the Americas, where native economy is not upset by the trader and the missionary.The use of a conventional medium of exchange, originally ‘fullbodied’ but developing into ‘token’ money, is first noted in the almost universal customs of ‘bride-price’ and wergeld. When sister-exchange is not practicable, some other value must be substituted; where life for life is not demanded, some equivalent must be found. The history of ‘bride-price’ and wergeld (which has yet to be written) shows how formal the customary gifts become, fitted to definite scales of value. It is not without significance that in any collection of primitive currency the majority of the items are described as ‘used in bride-price’.
When once a system of conventional gifts or payments with a definite scale of values has been established (and this is necessary for ‘bride-price’ and for wergeld) the first steps are taken in the evolution of money. …. The objects that come to be used as money are mainly non-local, or if local are the product of a special area or a special class; and they have prestige or essential virtue, religious or magical. Cowries and beads, most universal of all forms of primitive money, have magical as well as monetary value and still hold their own over a large part of the world, though everywhere disappearing now with the advent of the trader and trade tobacco. (Quiggin 1949: 321–322).

Paul Einzig argued a long time ago that it was possible that “money first developed to serve matrimonial, political or religious payments was only later adopted gradually for commercial purposes” (Einzig 1948: 984).

Even when commercial money does develop, gift exchange and credit/debt transactions in kind might remain the main method of exchange in tribal societies. Einzig, for example, notes how the indigenous people of the New Hebrides had a developed credit system denominated in terms of pigs, which arose from the sacrificial use of pigs (Einzig 1948: 984; Einzig 1949: 383). One can note how even ancient Greece – the basis of Western civilization – had a cattle standard of value in its Dark age and early Archaic age, which probably arose from the use of cattle in sacrifice (Seaford 2004: 61). The same general type of cattle unit of account seems to have developed in ancient India as well (Einzig 1949: 382).

Now how do the observations above fit in with other theories of money’s origins such as

And how does it fit in with the empirical evidence that a unit of account was developed by planners in temple institutions in ancient Egypt and Mesopotamia?

It fact, I would contend that it is perfectly complementary, because no single theory is the entire story. The subject of the origins of money is a deeply complex and difficult problem, and these are all pieces of the puzzle. It is obvious that the historical origin of money cannot be traced to one moment of invention in the past: for there have undoubtedly been multiple independent instances in history where things have emerged as a unit of account and medium of exchange in different societies in different times.

The existence and origin of “social currency” or “non-commercial money” is yet another important empirical fact ignored and neglected by economists.

To sum up: a useful conceptual division in any study of money is one between

Non-commercial money is mainly used in social interactions, often formal social events such as marriage, wergild and bloodwealth payments, political relations (potlatch, moka), and fines and compensations (compensation for adultery, or for things lost), and may only be rarely used for everyday purchases or commercial transactions.

Appendix: Georg Thilenius on Primitive Money

G. Thilenius (1921) introduced another relevant distinction with regard to money: he distinguished between “Nutzgeld” and “Zeichengeld.” Nutzgeld (“useful money”) refers to useful objects in exchange, while Zeichengeld (“token money”) refers to objects of ceremonial or token value (Quiggin 1949: 3). Thilenius also distinguished between natural money (“Naturgeld” or objects of nature) and cultural money (“Kulturgeld” or objects manufactured or produced by human beings). These are perhaps further useful conceptual distinctions to be borne in mind.

“Once the turning point is reached, ABCT tells us little to nothing about how the bust will play out. Yes, we know that further inflation and interventionist attempts to prevent the necessary reallocation of resources will make matters worse, but the theory by itself doesn’t tell us a priori how this will play out in any given historical circumstance. The ABCT is not a theory of the causes of the length and depth of recessions/depressions, but a theory of the unsustainable boom.

To turn to Christensen’s particular example: the ABCT cannot explain the entirety of the Great Depression. It simply can’t. And adherents of theory who make the claim that it can are not doing the theory any favors. What ABCT can explain (at least potentially, if the data support it) is why there was a recession at all in 1929. It argues that it was the result of an unsustainable boom initiated by an excess supply of money at some point in the 1920s. Yes, the bigger the boom, cet. par., the worse the bust, but even that doesn’t tell us much. Once the turning point is reached, there’s not a lot that ABCT can say other than to let the healing process unfold unimpeded. In the context of the Great Depression, one has to invoke other theories to explain why the bust, whose onset the ABCT explains, became so deep and so long. And that is where Friedman and Schwartz’s work on the 1929–33 period along with awful policies of the Hoover administration, ably documented by Rothbard in AGD and updated in this Cato piece of mine from last year, are required to explain why things got so bad so quickly.”Steven Horwitz, “What the Austrian Business Cycle Theory Can and Cannot Explain,” Coordination Problem, February 11, 2012.

Even if one were to accept the validity of the ABCT as Horwitz himself does, there is a serious problem in this argument.

Having asserted that the ABCT does not explain the depth or length of the Great Depression (for which other explanations are necessary, he says), Horwitz commits a non sequitur: he contends that nothing must be done by government to “prevent the necessary reallocation of resources,” and that the healing process must “unfold unimpeded.” These ideas do not follow. And, in appealing to the work of Friedman and Schwartz on the Great Depression, Horwitz can only be tacitly endorsing the view that it was lack of central bank stabilization of the money supply that has a major factor in exacerbating the downturn. This means government interventions are required in such circumstances.

Saturday, February 11, 2012

Economists have arguably neglected the unit of account (or measure of value) function of money, and instead focused too much on money’s medium of exchange role.

A. Chapman has made the following important point about money as a measure of relative values:

“… scholars such as Marx (1973: 142), Schneider (1974: 255) and Melitz (1970: 1027) concerned with the prehistory of money have noted that the standard usage occurs quite independently from money as a universal equivalent, also termed all-purpose money. Referring to Menger, Einzig (1949: 367) even suggests that standards for evaluating stored wealth may historically have preceded barter. This seems unlikely if only because most known hunters, gatherers and fishers did not accumulate much ‘wealth’ but many did barter. The standard is not necessarily represented by a material object. For example, it may consist of imaginary units or of a mathematical device for calculating relative worth of goods against a given symbol or entity.” (Chapman 1980: 53).

A related question is how the development of a measure of value for evaluating the worth of various kinds of stored wealth might have had a role in origins of money.

When we examine those early civilizations where stored wealth came to be an important element in the community, it makes a great deal of sense.

The origin of money in ancient Mesopotamia appears to be in the development of an abstract money of account in the temple and palace institutions. These temples and palaces were institutions with large internal centrally planned economies, with complex weights and measurements for internal accounting of the products produced, received and distributed, and rent and interest owed. Many prices were set and administered in the money of account which developed from weight units. The two units of account were (1) the shekel of silver (which was equal to the monthly grain ration) and (2) barley (Hudson 2004). Silver money of account spread to the private economy mostly notably as a means of paying debts to temples and palaces (Hudson 2004: 115). But many ordinary people could pay in commodities, and the administered pricing system in terms of silver/grain developed in the temples was to assist in calculation of payments in kind.

In ancient Egypt, money appears as the most important unit of account called the deben (or uten), which was a unit of weight, originally equated to 92 (or 91) grams (Henry 2004: 92; there was also the unit called the khar for measuring wheat or barley, and 1 khar was equivalent to 2 deben of bronze). The measure of value for various goods was thus fixed weight units and historically no doubt these units arose from copper, silver, grain and gold. The unit of account system appears to have been developed by complex palace, government and temple institutions for internal accounting. While goods came to be denominated in terms of deben, in early times during the period of the Old Kingdom there were no physical deben changing hands in the private economy. That is to say, the deben did not function as a physical means of payment, and did not emerge by barter spot transactions as the most saleable medium of exchange. Even though goods and services were measured in a deben unit of account, payment was made in goods.

An important element in both these historical processes was the institution (or institutions) where surplus products were stored from taxation, tribute and gifts. These institutions dealt with complex flows, in and out, of goods: they were palace and temple complexes. Accounting systems, weight measures and writing are connected with just such institutions, and, importantly, some abstract unit of account arose by which to measure relative values of stored goods and inflows or outflows of goods. Since loans were also no doubt made from surplus products stored, repayment of loans in kind was facilitated by a unit of account.

In primitive human societies by the end of the Stone Age (c. 2.9 million years to 4500 BC), before the literate urban civilizations, agricultural communities developed where surpluses were stored, most probably held as a communal resource. The question of how the origins of a unit of account or measure of value could be related to the emergence of stored wealth is an interesting research question that deserves further study.

Ludwig von Mises was the founder of the Austrian business cycle theory (ABCT). The theory was originally called the “circulation-credit” theory of the business cycle. Mises’s various versions of his business cycle theory can be found in these works:

(1) The version of Mises in The Theory of Money and Credit (trans. J. E. Batson; Mises Institute, Auburn, Ala. 2009 [1953]), pp. 349–366. The first version presumably appeared in the original German edition, the Theorie des Geldes und der Umlaufsmittel (The Theory of Money and Credit; Munich and Leipzig, 1912) and the 2nd German edition published in 1924. An English translation appeared in 1934.

(2) Mises’s version in Monetary Stabilization and Cyclical Policy (1928) that can be found in Mises 2006 [1978], p. 99ff.

(4) The version in Human Action: A Treatise on Economics (Auburn, Ala., 1998 [1949]), pp. 568–583.

Hülsmann has a pertinent discussion of the flaws in the original theory of Mises in The Theory of Money and Credit:

“In light of his theory of interest, Mises now clarified the relationship between interest and changes in the quantity of money. The Austrian (Misesian) theory of the business cycle asserts that intertemporal misallocations result from inflation-induced reductions of the interest rate. But what was the precise meaning of ‘reduction’? Mises did not mean to assert that simple changes of the interest rate would induce a business cycle. The fact that today’s interest is lower than yesterday’s does not by itself mean that a misallocation has occurred.

In his Theory of Money and Credit, Mises had based his analysis on the Wicksellian distinction between the natural rate of interest and the money rate. But this distinction was untenable in light of Mises’s work on economic calculation and on the non-neutrality of money. There is no such thing as a natural rate of interest, defined as the rate of interest that would prevail in a barter economy. And even if there were such a ‘natural’ rate of interest, it would still be irrelevant for the analysis of a monetary economy. Money is not just a veil over a barter economy.

It affects all economic relations. Prices, incomes, allocation, and social positions in an economy using money are completely different from what they would be in a society with no common medium of exchange. And so the interest rate in a monetary economy is necessarily different from what it would have been in the same economy if the market participants had decided to forgo the benefits of money. Even if one could hypothetically compare ‘natural’ and money interest rates—which is not the case—it would not follow that intertemporal misallocations would ensue whenever the ‘natural’ rate was higher than the money rate.

In Nationalökonomie, Mises gave a new exposition of his business cycle theory. He came up with a new benchmark to identify pernicious reductions of the monetary interest rate. The relevant benchmark was no longer the Wicksellian natural rate that would exist if the economy were a barter economy. It was rather the monetary interest rate that would exist in the absence of credit expansion. Any increase in the supply of credit on the market will reduce the interest rate, but if the increase comes from printing paper money or banknotes (rather than from savings) then the artificially lower interest rate falsifies the entrepreneurial profit calculus. In light of the decreased interest rate, a greater number of business projects appear to be profitable and are launched. But the material factors of production necessary for the physical completion of the greater number of projects do not exist.

Credit expansion does not mean expansion of the real factor endowment of the economy; it merely means expansion of the money supply through the credit market. It follows that it is physically impossible to sustain the new structure of production that resulted from the credit expansion. The boom must eventually end in a bust.” (Hülsmann 2007: 779–781).

Hülsmann is entirely correct about the non-existence of Wicksell’s natural rate of interest. Mises’s exposition of the ABCT in The Theory of Money and Credit (trans. J. E. Batson; Mises Institute, Auburn, Ala. 2009 [1953]) and Monetary Stabilization and Cyclical Policy (1928) both use the Wicksellian unique natural rate of interest concept. It follows that both these expositions are severely flawed.

But Mises’s new version of his business cycle theory in Nationalökonomie (and developed in Human Action) still has major flaws, as follows:

(1) it assumes an economy with no idle resources and no international trade. In reality, capitalist systems have historically had many periods where there are significant idle resources, like labour, raw materials, capital goods and other factor inputs. If an economy with significant idle resources has investment via fractional reserve banking or central bank creation of excess reserves, how will the inflationary pressures imagined by ABCT happen if productive resources simply do not need to be freed in the stages close to consumption? Such factor inputs will be available or quickly made available through increasing capacity utilization in the relevant industries, or even imported from overseas. Versions of ABCT dispensing with a Wicksellian natural rate of interest fail to explain why the cycle effects would happen if factor inputs were not scarce and available through international trade. And even when resources become scarce the theory still has problems.

(2) Like all versions of ABCT, it assumes that credit flows primarily or exclusively to producers engaged in capital goods investments. It is obvious that this is a grossly simplistic and unrealistic assumption in the modern world. Credit today is a complex composite of flows to create consumer loans, loans to speculators on assets or primary commodities, and loans for capital goods investments. When booms in business cycles are primarily driven by credit flows to speculators who blow asset bubbles, the dynamics of the boom are different from those of booms in (allegedly) unsustainable high-order capital goods investments, as assumed by ABCT.
As a concrete example, in the 2000s the economic effect of subprime loans (such as liar’s loans or NINJA loans), where people used their houses as ATMs, was an asset bubble in housing, from which exotic CDOs were created. These effects – essentially caused by consumer loans – are clearly very different from the alleged distortions of capital structure imagined in the ABCT. Even if we assume that alleged unsustainable capital structure distortions occurred, they would be swamped by effects coming from consumer credit expansion and debt deflation.

(3) Underlying Mises’s new theory is still the mistaken time preference theory of interest rates.

(4) As Robert Vienneau has argued, there is no necessary reason why lower interest rates would cause production to be re-oriented to higher-order capital goods anyway, and even classifying capital structure into well-defined higher orders is dubious in itself (see Vienneau 2006 and 2010).

(5) The development of any boom in the business cycle is dependent on a myriad of factors, and whatever future profit any particular capital goods project will deliver can only be a matter of subjective expectation in the present. A rise in interest rates may decrease the demand for credit and raise the burden of servicing debt, but, if there is a mutual expectation that a particular investment might deliver future profit by the bank and business, it is normal for businesses to refinance their investment loans or have the loans rolled over by banks.

(6) In the real world, even when inflationary booms occur, the causes of recession and depression are often very different from the ridiculously simple Austrian business cycle theory. The business cycle after WWII down to the 1980s was rather different from the pre-1933 business cycle. The post-war world saw downturns that were mostly “inventory recessions.” Recessions from the 19th-century to the 1930s often (though not always) conformed to a pattern of bursting asset bubbles, financial crises, bank runs and debt deflation. The Austrian trade cycle theory says nothing about asset bubbles in financial markets or real assets like housing. In the 1990s and 2000s, many nations have experienced asset bubbles and the debt deflation-type of recession once again (or balance sheet recession), after neoliberal economics introduced lax and ineffective forms of financial regulation.

Friday, February 10, 2012

In 1949, A. H. Quiggin published A Survey of Primitive Money: The Beginnings of Currency (London). The summary of the author’s views on the origin of money is worth quoting:

“Writers on the origin of the use of money often start with a consideration of barter and its inconveniences. From ‘silent trade’ (a primitive though abnormal form of barter) they trace the evolution of trading and money side by side, relying mainly on literary evidence for probing into the past.
This study relies mainly on the tangible evidence of the actual types of primitive money or money-substitutes used by ‘unrisen’ people and others all over the world, and is concerned with the purposes, when discoverable, for which they were used. The evidence suggests that barter in its usual sense of exchange of commodities was not the main factor in the evolution of money. The objects commonly exchanged in barter do not develop naturally into money and the more important objects used as money seldom appear in ordinary everyday barter. Moreover, the inconveniences of barter do not disturb simple societies. The variety of material and the complexities of uncivilized attitudes towards money preclude generalizations, but the evidence appears to support the following line of argument.
In the beginning Man lived in self-supporting and self-contained groups. Except in an area where provisions are unlimited, a society depending on hunting and food-gathering for its subsistence is necessarily unsociable and ‘has no truck’ with its neighbours. Early exchanges were in the way of present-giving, and were expressions of friendship with no ulterior economic purpose, although the latter – an expectation of an adequate or even improved return – cannot be excluded from human dealings. Present-giving or gift-exchange, seen in simple forms in the Andamans, Torres Straits or New Zealand, may develop into elaborate ceremonial as in Fiji or the North-West of America, but remain distinct from trading with money.
Barter develops between areas of contrasted produce, such as coastal and inland, forested and open country. We see the barter of fish or shells for vegetables, game for bananas, &c., in Melanesia or the Congo, and the establishment of regular markets. Trading voyages such as those of Torres Straits and New Guinea take us a stage further by the introduction of conventional presents. But so far there is no need for any medium of exchange such as is commonly described as money.
This is the state of affairs over about half the world at the present day. Barter suffices for most of the natives of Australia, New Zealand and the islands of the Pacific, and for the less-advanced peoples of Africa, Asia and the Americas, where native economy is not upset by the trader and the missionary.The use of a conventional medium of exchange, originally ‘fullbodied’ but developing into ‘token’ money, is first noted in the almost universal customs of ‘bride-price’ and wergeld. When sister-exchange is not practicable, some other value must be substituted; where life for life is not demanded, some equivalent must be found. The history of ‘bride-price’ and wergeld (which has yet to be written) shows how formal the customary gifts become, fitted to definite scales of value. It is not without significance that in any collection of primitive currency the majority of the items are described as ‘used in bride-price’.
When once a system of conventional gifts or payments with a definite scale of values has been established (and this is necessary for ‘bride-price’ and for wergeld) the first steps are taken in the evolution of money. It develops thereafter in response to human needs into the accepted medium of exchange. Nutzgeld still remains Nutzgeld. Cattle may constitute wealth and form a standard of value. They cannot, strictly speaking, be called money. Money, to be generally acceptable, needs more convenient material and finds the four essential qualities (portable, divisible, durable, recognizable) in shells, beads or metals. Two further qualities have been shown to be necessary, one geographical and one more difficult to define.The objects that come to be used as money are mainly non-local, or if local are the product of a special area or a special class; and they have prestige or essential virtue, religious or magical. Cowries and beads, most universal of all forms of primitive money, have magical as well as monetary value and still hold their own over a large part of the world, though everywhere disappearing now with the advent of the trader and trade tobacco. Metals best illustrate the transition from ‘full-bodied’ to ‘token-’ money. The spears and hoes of Africa, the knives and spades of China, and the spits of Argos are familiar examples. The tools may become amorphous and valued according to their weight in metal, or survive as attenuated imitations of their former selves. Metal, whether gold, silver, copper, iron or tin, is everywhere useful and everywhere valued, and estimated by size, shape or weight. Ingots are preliminary stepping-stones to coins. Ingots, as lumps or bars, develop in response to local needs or whims in special forms, such as manillas, Katanga crosses and Kissi pennies, Malay hats and Siamese bullets, or our own currency bars and ‘ring-money’.

To us, looking backward, the next step appears obvious and inevitable, but it was only in rare spots (possibly only in one rare spot) in the Old World that the final stage was reached, and definite weights of metal, rounded, flattened and stamped, can be called coins. Here the study of primitive money comes to an end.” (Quiggin 1949: 321–322).

It is remarkable how the details of the modern anthropological critique of the economists’ view of the origin of money were already available in 1949: gift exchange is the usual form of internal commodity exchange; barter spot trade has been most significant between societies; barter is not the only story in the origin of money (although there are instances of money emerging this way); and social practices such as wergild and bride-price also have a role to play in the origin of money.

Most astonishing is the observation that “primitive” money has historically been thought to have magical properties by human beings, a state of affairs far from the limited and wretchedly ignorant ideas of economists, who rely too much on a priori theorising.

In many ways, what Graeber (2011) writes on the origins of money is a useful, modern re-statement of what has been known for some time.

(1) The neoclassical economics profession’s obsession with barter stems from the belief that money is a neutral veil and that economies can be modelled as barter systems (Graeber 2011: 44–45).

(2) On pp. 46–52 of Debt: The First 5,000 Years, Graeber reviews the credit theory of money and chartalism. Mitchell Innes made the point that money units are abstract units of measurement, and that such units can emerge before concrete tokens of exchange. The use of debts as a medium of exchange and means of payment is an important element of the story of money. The origin of money in Mesopotamia appears to demonstrate how a unit of account can emerge in a way other than the barter spot trade. The silver unit of account was developed in the temples, and it is in fact interesting how cattle, gold and silver, objects emerging as money in many societies, are also high prestige objects that were offered to the gods (Graeber 2011: 59).

(3) Graeber refers to Primordial Debt Theory, advanced by Michel Aglietta, Andre Orléans, and Bruno Thére (Graeber 2011: 55), although in the end dismisses their theory as another myth (Graeber 2011: 62). The Primordial Debt Theorists take up the thesis of Grierson (1977 and 1978), and emphasise the role of wergild-like social practices, penalties and fines in the emergence of money. In gift exchange economies, it is difficult to imagine how a system of commodity equivalences or calculating relative values arises, but when fines and compensations need to be paid, this is actually when people demand precise and exact compensation in terms of goods lost and goods deemed to be equivalent.

(4) In societies where there exist what we might call “primitive” money, such as shell money in the Americas or Papua New Guinea, cattle money in Africa, bead money, feather money, and so on, these monies are often used exclusively in social interactions like arranging marriages, establishing paternity of children, compensation, or consoling mourners over the dead (Graeber 2011: 60; 130), not for exchanging everyday items and sometimes not even for buying or selling anything at all (Graeber 2011: 130). Such monies are called “social currencies” by Graeber (2011: 130).

Graber makes the following observation:

“One of the puzzling things about all the theories about the origins of money that we’ve been looking at so far is that they almost completely ignore the evidence of anthropology. Anthropologists do have a great deal of knowledge of how economies within stateless societies actually worked—how they still work in places where states and markets have been unable to completely break up existing ways of doing things. There are innumerable studies of, say, the use of cattle as money in eastern or southern Africa, of shell money in the Americas (wampum being the most famous example) or Papua New Guinea, bead money, feather money, the use of iron rings, cowries, spondylus shells, brass rods, or woodpecker scalps. The reason that this literature tends to be ignored by economists is simple: ‘primitive currencies’ of this sort is only rarely used to buy and sell things, and even when they are, never primarily everyday items such as chickens or eggs or shoes or potatoes. Rather than being employed to acquire things, they are mainly used to rearrange relations between people. Above all, to arrange marriages and to settle disputes, particularly those arising from murders or personal injury.” (Graeber 2011: 61).